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Rolling Into Q4 Earnings Season With Low Expectations

To put into context just how low expectations have gotten for the fourth quarter earnings season, if the Dow Jones Industrial Average (^DJI) had suffered a commensurate decline over the past 3 months, we would be trading about 4,000 points lower today at 9,400, rather than 14,300. Had that actually have been the case for stocks over the past 90 days, not only would the election outcome have been different, the holidays ruined and the fiscal cliff long since settled, but the stream of agonizing, depression-like headlines would be unbearable.

And yet, that is exactly what has happened to Q4 earnings projections for the S&P 500 since the start of October. According to Factset, a 70% drop in growth estimates has taken consensus to just 2.7% EPS growth, down from 9.2% at the start of the quarter.

While analyst estimates almost always come down during the quarter, this round of projection pessimism is particularly stark.

"A lot of what the market will be looking at is for projections going forward," says David Lutz, head of ETF trading at Stifel Nicolaus, in the attached video. As he sees it, there will be "so much skew in these earnings" due to the Fiscal Cliff, the election and Hurricane Sandy, that it will make discerning the winners and losers all the more difficult.

"It will be interesting to see if we follow the pattern of the past two earnings seasons; sell the news," Lutz says ahead of Alcoa's (AA) report due out after the close tomorrow. Factset data shows that the aluminum company beat estimates the past two quarters, but both times shares fell more than 4%.

"Another thing that's going to be on investors' minds is, what is the running commentary," Lutz predicts, adding that he "think companies will be relatively pessimistic with their outlooks.

Fittingly, analysts have already been slashing their forward estimates too. Factset reports first-half 2013 growth estimates are coming in at a sharp pace with analysts halving their Q1 growth estimates to 2.5% from 5.3%, and cutting their Q2 numbers by a third to 6.7% from 9.1%.

And yet, all this looming heaviness and pessimism may prove to be an opportunity.

"At the end of the day, I think a lot of the weakness in earnings season, coupled with a lot of the concerns with Washington's deal at the end of February, will probably be bought," Lutz says, while pointing to a personal interest in the bank stocks (XLF).